In a PR nightmare, Medtronic (MDT) recently announced that it will pay $23.5M to close allegations that it bribed doctors to implant its products into patients. Competitor Boston Scientific (BSX) has a problem of its own: a notice of tax deficiency from the IRS. Scandals aside, both firms have strong fundamentals despite a challenging environment. However, I believe that Medtronic - which has been outperforming for some time now - remains more attractive on the basis of risk/reward.
From a multiples perspective, Medtronic is the cheaper of the two. It trades at only a respective 11.2x and 9.5x past and forward earnings, while offering a dividend yield of 2.7%. Boston Scientific does not offer a dividend, and trades at a respective 14.3x and 10.8x past and forward earnings. In addition, Medtronic has gross margins that are approximately 870 basis points larger than that of its competitor. With that said, this may actually be seen as a catalyst for the latter, since the firm has greater flexibility in trimming SG&A and other expenses.
At the second quarter earnings call, Medtronic Chairman & CEO Omar Ishrak noted strong performance:
This morning, we reported a second quarter revenue of $4.1 billion, which represents growth of 6% as reported or 3% on a constant-currency basis. Q2 non-GAAP earnings of $898 million and diluted earnings per share of $0.84 increased 1% and 2%, respectively.
Our Q2 results reflect a quarter of stability in a challenging market. New products are making a difference in many of our businesses, and our international markets continue to deliver solid results. Once again, over 60% of our revenue grew a combined 80%. This portion of our business has steadily delivered improving growth over the last 5 quarters. It's also worth noting that the same set of businesses grew a combined 9% in the U.S., demonstrating that the U.S. healthcare system still recognizes the value of innovative products.
EPS of $0.84 slightly beat the consensus estimate of $0.82, due largely to better-than-expected gross margins and a lower tax rate. ICD benefited from the release of Protecta, which allowed for premium pricing. Sales here totaled $708M - a decline of 5% y-o-y, but still exceeding the $700M consensus. This product release was particularly notable because it shifted the company's business mix towards higher margin areas. Spinal revenues were additionally strong, and renewed confidence in demand. Going forward, Medtronic will benefit from the FDA advisory panel approval of label expansion for MDT's CRT-D into Class II NYHA patients. I am anticipating that ROIC will expand by 100 basis points by 2014.
Consensus estimates for Medtronic's EPS are that it will grow by 2.4% to $2.45 in 2012 and then by 8.1% and 6.2% more in the following two years. Of the 19 revisions to estimates, the majority, 16, have gone up. Assuming a multiple of 14x and a conservative 2013 EPS of $3.60, the rough intrinsic value of the stock is $50.42. This implies 42.2% upside and compares to only 21% downside. The downside figure arises from a bear case scenario that the multiple plummets to 8x and 2013 EPS turns out to be 6.2% below the consensus at $3.50.
Boston Scientific is in a slightly more precarious position. Publications have indicated that the firm's Element platform has greater LC risk than Medtronic's stents. According to one analyst, however, doctors have indicated that the risk is acceptable due to Element's excellent radial strength. In addition, with the FDA's recent approval of Boston Scientific's Progeny platform, the firm will now begin to penetrate the ICD market and take away share from its competitor.
Consensus estimates for Boston Scientific's EPS are that it will grow by 7.1% to $0.45 and then by 8.9% and 12.2% more in the following two years. Assuming a multiple of 14x and a conservative 2012 EPS of $0.47, the stock is discounted 24.4% to intrinsic value. This does not meet the threshold that I consider to indicate a value play. Analysts currently rate shares of the firm a "hold" and those of Medtronic a "buy."
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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